Overviews

Commercial banks are similar to many other businesses in that they are in business to make money (usually for shareholders). But banks are quite different from other businesses that sell tangible products or provide services. Banks don’t buy raw materials and turn them into products, nor do they only provide a service or advice (they do in many cases provide financial advice, but that’s not usually the bank’s primary business). Fundamentally banks are a financial intermediary; that is, they buy and sell money. Basically banks take customer deposits (buy money) and they loan it out to other customers (sell money).

If you looked at a bank’s balance sheet you would see four broad categories of assets: loans, securities, overnight investments, and other assets. On the liability or funding side you would also see several broad categories: deposits, wholesale debt, overnight borrowings, other liabilities, and finally equity (or capital).

Ultimately banks make money by finding the right mix or balance between assets and funding. It’s a balancing act and the financial management process is often called Balance Sheet Management or Asset/Liability Management.

BANKdynamics give you the opportunity to assume the role of a senior bank executive. It will be your job make decisions regarding loan rates and total dollar volume. How much business do you want and what credit risks are you willing to take? Can you set your deposit rates to generate acceptable deposit volumes? Can you deal with aggressive competition? You’ll also have the opportunity to add or take away from your overhead expenses (hire or fire people). And you can make decisions regarding your capital position (should you pay dividends, or sell more stock?).

BANKdynamics will expose you to several key bank management issues; for instance what financial measurements or targets do banks use to gauge their financial returns? Also, how do banks measure and manage their three primary financial risks (Asset Quality, Liquidity, and Interest Rate Risk)? As the new management team for the simulation bank you’ll be asked to set managerial goals for risk and return.

The key component of BANKdynamics that will help you learn about balance sheet management is the What-If. The what-if is a collection of decisions or attempts at changing the bank. You can ask as many what-ifs as you like. You can try completely different strategies and compare the results. Here is a post that talks more about the benefits of the what-if.

Facilitator enters decisions from all teams into the simulation software & runs the competition

Facilitator distributes to the teams a printed copy of the results from competition

Teams review results and then return to Step 3 for another round or "quarter" of simulation

Most of the teams, unless they've run the simulation before, will make more than a few decisions that cause their bank to stumble down a path that's very rough and rocky. I call this the "black-hole" approach to simulation because the teams are given just one shot, one chance, at getting it right each quarter. They turn in their decisions to the facilitator and hope that everything turns out ok when the results come back.

At first glance this doesn't seem to be such a bad approach. A team is given the chance to "correct" or "fix" any problems they've created in the next round (or quarter). It is a simulation after all. You're supposed to make mistakes in a simulation...better there than in the real world.

But there is a problem with this typical bank simulation process. The schedule & software seldom allows participants more than six or eight chances to make decisions. There either isn't enough time allotted for more rounds (or there aren't enough resources available to "key-in" decisions).

Imagine running Microsoft's flight simulator with the limitation that you can only run it eight times and then your done. You can't run it anymore. I don't know about you, but it took me eight attempts just to learn some of the controls, forget trying to perfect a take-off or landing.

The more you are allowed to interact with a simulation the more you are likely to learn. That's what really makes BANKdynamics different from other simulations...the what-if (or WIF). Here's what happens in a BANKdynamics competitive simulation:

Participants are organized into teams

Teams review the case bank

Teams identify several operating/management decisionsa. Teams take a snapshot of these decisions by creating & calculating a WIFb. Teams review the potential results of these decisions by looking at WIF reportsc. Teams modify these decisions, or perhaps throw them away and start over with a new setd. Teams return to step 3.a. and repeat steps b through d several times..

Teams identify their best or "most liked" WIF

Once all teams have identified their best WIF, the facilitator clicks a button to start the competition (no re-keying team decisions!)

Facilitator notifies teams that the competition is finished and the results are available online (no printing required!)

Teams review results and then return to Step 3 for another round or "quarter" of simulation

Compared to the typical bank simulation there are more than a few differences. The biggest difference is in step three. If you believe that "trying things out" is the whole point of an enriching simulation exercise, then you cannot deny that BANKdynamics offers a team much more opportunity to do so via the WIF. BANKdynamics offers a team multiple opportunities to "try things out" by creating multiple WIFs.

Teams aren't the only ones to benefit. The individual team members can have a more enriching experience too. One reality of the team work in typical bank simulations is that, because there is a limit on "trying things out", the team majority rules when it comes to decision time. Any individual curiosity about the impact of a particular decision is squashed if the majority of the team doesn't agree. Here's a typical team discussion in a traditional bank simulation:

Bank President: OK, time is short so do we all think this is the set of decisions to go with?

VP #1: Yes, I think this will bring earnings back to a satisfactory level.

VP #2: But what about our rising non-performer level? Should we address the credit quality issue? I think a small increase in staff would help.

VP #3: No way! That would probably kill earnings to add more overhead. And besides, I think the impact on non-performers would be minor.

Bank President: I agree, sorry VP #2, three against one, but please keep the suggestions coming.

I added the emphasis to the words think and probably on purpose. The point is that these team members don't have any sort of analytical information other than historical performance to make these decisions. VP #2 might have a good idea, but nobody can look at a projection or proforma to help them decide...so the idea is lost.

In BANKdynamics the conversation might go a bit differently:

Bank President: OK, time is short so do we all agree that What-if #23 is the one to go with?

VP #1: Yes, the preliminary reports show a projected ROE of over 15% which is our target.

VP #2: But what about our rising non-performer level? Should we address the credit quality issue? WIF #23 also projects non-performers to rise above 0.50. A small increase in staff would help.

VP #3: No way! That would probably kill earnings to add more overhead. And besides, I think the impact on non-performers would be minor.

VP #2: I disagree, I ran another projection, WIF #24, and compared it to WIF #23. Look, ROE is still over 15%, and non-performers stays below 0.25!

VP #3: That's good news! In that case I think we should add the small amount of overhead. I vote for WIF #24.

In BANKdynamics not only does the team have the ability to ask and analyze WIFs, but each individual member can ask them to. More importantly they can compare their individual WIFs to one another and evaluate the relative strengths and weaknesses. There's no reason for that good idea to be lost!

Allowance for Loan Losses A valuation reserve to provide for possible losses on loans. The reserve is a contra-asset which is subtracted from total loans to determine the net carrying value of loans for a bank's statement of condition. Also referred to as reserve for loan & lease loss.

Asset Quality Risk The potential loss of cash flows due to poor quality borrowers or counterparties; low investment grades of securities; or excessive concentration of similar assets and contracts.

Balance Sheet Mix Asset, liability, and equity accounts all stated as a percentage of total assets on the balance sheet date (EOP).

Book Value The amount for an item shown on the statement of condition which follows generally accepted accounting principles (GAAP). In many instances, book value is the original transaction value, plus or minus any premium, discount, or other amortization adjustment. For some items, however, GAAP now requires the use of fair value such as is the case for investment securities classified as available-for-sale.

Borrowed Funds Includes all funds acquired from creditors in the form of debt, payable in less than one year and usually at money market interest rates.

Capital Adequacy The level of capital funds required to support the institutional structure and to provide protection against unanticipated and excessive losses. In the A/L BENCHMARKS Peer Information a balanced growth of loans, assets, deposits, and capital; acceptable leverage; and risk-based capital of 10% or better (well capitalized) are indications of adequate capital.

Cash In the A/L BENCHMARKS Peer Information, cash includes till cash, cash reserve balances, deposits with other banks, and items in process of collection.

Charge-offs Loans which have been written off the books and charged against the allowance for loan losses.

Commercial Loans See Loans

Consumer Loans See Loans

Core Deposits Includes Noninterest Deposits, NOW and Savings Deposits, and Money Market Deposits.

Cost of Funds The cost of funds percentage is total annualized interest expense divided by total average interest-bearing funds, including deposits and all borrowed funds.

Deposit Present Value Premium The amount by which the book value of total deposits exceeds the computed present value (market value) of total deposits.For purposes of the A/L BENCHMARKS Peer Information, the present values of the various deposits were computed using the discounted cash flow method. The maturity assumptions for non-maturing deposits (decay factors) are indicated by the duration estimates (IRE) for each deposit classification.

Earnings at Risk See Net Earnings at Risk and Net Interest Earnings at Risk

Equity Value at Risk The potential adverse change in the present value (market value) of total equity (MVPE) arising from an assumed change in interest rates.

For the A/L BENCHMARKS Peer Information, the base MVPE is determined by subtracting the present value (market value) of total liabilities from the present value (market value) of total assets. Present values for assets and liabilities are either current quoted market prices or discounted cash flows using current market rates. The potential adverse impact on present value of equity is calculated by using a +/-200 basis point change in interest rates; assuming a parallel shift in the treasury yield curve; and simulating changes in repricing, prepayments and other rate-driven parameters which effect the level and timing of cash flows.

Growth Rate (Annual growth rate) The year-to-year change in the account balance expressed as a percentage of the prior year’s balance.

Growth Rate - Balance Measure A measure of the difference between the highest and lowest of four growth rates (loans, assets, deposits, and equity). The smaller the difference, the better the balance among the four growth rates.

For example, if all four of the growth rates were exactly 3.76%, then the difference between the high and low percentage is zero and the growth rates are in perfect balance. Alternatively, if the four growth rates were 23.5, 18.2, 9.8, and 2.3, the difference between the high and the low percentage is 21.2.

Interest Rate Elasticity(IRE) IRE is a measure of interest rate sensitivity. It is the expected percentage change in the present value (market value) of a financial instrument or portfolio of financial instruments if market yields increase 100 basis points.

In addition, IRE can be used to estimate Macaulay’s duration. Macaulay’s duration is the present value weighted average time until all the cash flows from a financial instrument or portfolio will be received or repriced to current market rates. As a measure of Macaulay’s duration, the IRE percentage is used to express the number of years to receive or reprice cash flows.

Interest Rate Risk The potential economic losses due to future interest rate changes. Economic losses can be reflected as a loss of future net interest income (earnings at risk); a loss of current fair market values (value at risk); or both.

Mean The sum of a group or sample of values divided by the number of observations in the group or sample.

Median The value of the middle or center-most item within a group or sample.

MVPE (Market Value of Portfolio Equity) The present value (market value) of total assets, less the present value (market value) of total liabilities.For purposes of the A/L BENCHMARKS Peer Information, market values of assets and liabilities are quoted market prices or calculated present values for all financial instruments. For non-financial instruments, the book or carrying value is assumed to be market value.

Net Borrowed Funds Short-term borrowed funds less short-term investments. A negative value represents net funds sold. When used in the ratio of net borrowed funds to equity, the average net borrowed funds (either positive or negative) is divided by average equity.

Net Charge-Offs Charge-offs less recoveries. When used in the ratio of net charge-offs to total loans, net charge-offs is divided by average total loans.

Net Earnings at Risk The potential adverse change in net income arising from a change in interest rates, measured over a one-year forecast horizon.For the A/L BENCHMARKS Peer Information, the base net income is computed using a current or constant forecast of statement of condition balances, market interest rates, and noninterest items. The potential adverse net income is calculated by using a +/-200 basis point change in interest rates; assuming a parallel shift in the treasury yield curve; simulating changes in repricing, prepayments and other rate-driven parameters which impact cash flows; and assuming all noninterest items will not change.

Net Interest Earnings at Risk The potential adverse change in neat interest income arising from a change in interest rates, measured over a one-year forecast horizon.For the A/L BENCHMARKS Peer Information, the base net interest income is computed using a current or constant forecast of statement of condition balances, market interest rates, and noninterest items. The potential adverse net interest income is calculated by using a +/-200 basis point change in interest rates; assuming a parallel shift in the treasury yield curve; and simulating changes in repricing, prepayments and other rate-driven parameters which impact cash flows.

Net Interest Income Interest income from all earning assets less interest expense on all interest bearing deposits and liabilities. Generally, interest income includes fees on loans, amortization of premiums on securities, and accretion of discounts on securities.

Net Overhead Noninterest expense minus noninterest income, exclusive of security gains/losses. When expressed as a percentage, the annualized dollar amount of net overhead is divided by average earning assets.

Non-Core Funding Dependence % A measure which shows the relationship between long-term earning assets and non-core liabilities net of short-term investments. Long-term earning assets are investment securities which mature beyond one year, other real estate owned, and net loans reduced by acceptances from other banks and commercial paper. Non-core liabilities are time CDs and open account time deposits greater than $100K, other borrowed money, foreign office deposits, brokered CDs less than $100K, securities sold under agreement to repurchase, federal funds purchased, and demand notes issued to the U.S. Treasury. Short-term investments are interest bearing bank balances, federal funds sold, securities purchased under agreement to resell, debt securities with remaining maturity less than one year, acceptances from other banks, and commercial paper.

Non-Performing Assets Includes non-accruing, renegotiated, and 90-days or more past due loans. Non-Performing assets also includes other real estate owned and other foreclosed loan collateral.

Long-term earning assets are investment securities which mature beyond one year, other real estate owned, and net loans reduced by acceptances from other banks and commercial paper.

Short-term non-core liabilities are the portion of time CDs and open account time deposits greater than $100K, other borrowed money, foreign office deposits and brokered CDs less than $100K which mature within one year, plus securities sold under agreement to repurchase, federal funds purchased, and demand notes issued to the U.S. Treasury. Short-term investments are interest bearing bank balances, federal funds sold, securities purchased under agreement to resell, debt securities with remaining maturity less than one year, acceptances from other banks, and commercial paper.

Standard Deviation or Std. Dev. The statistical measure of variance from the mean representing the dispersion of data (distance) from the mean.

Total Risk-based Capital Total capital divided by risk-weighted assets. Total capital is tier 1 capital plus a defined portion of the allowance for loan losses, subordinated long-term debt, and miscellaneous other qualifying equity or near equity items.

Total Loans See Loans

Treasury Yield Curve The treasury yield curve represents the relationship of yields on U.S. Government debt instruments of various maturities at a point in time. The treasury yield curve, also known as the term structure of interest rates, is charted daily in The Wall Street Journal and other business publications.

Long-term earning assets are investment securities which mature beyond one year and all loans. Short-term funds are large time deposits, foreign office deposits, federal funds purchased, securities sold under repurchase agreements, trading liabilities net of revaluation losses, and other borrowings maturing within a year. Net short-term funds are net of short-term investments.

BANKdynamics News is viewed by all participants in any bank in any city and carries announcements that apply to all.

BANKdynamics Industry News tells you about rate changes. Participants can not post messages to this box.

Community Bulletin Board is specific to your city.

Inter-Office Mail is seen only by your team members

Team Administration/Personal Info

"a.k.a": You may define a nickname for yourself, the bank, or your teammate.

Title: Create one or select from the drop down box.

Leader: The one whose decision is entered at the time competition. Review the leader before each decision. The leader can change during the game, but the person who is selected in the leader box at the start of each competition is whose marked What-if is selected.

Slogan: You may develop a catchy slogan for your bank, but it is not required.

Logo: You may change the standard logo, if desired.

Personal Info: This information is critical if the simulation is run exclusively via the web.

Discussion: The interest rate environment used in the case is based on actual yield curve rates in history. The yield curve for December 31, 2020 matches the actual curve that existed on December 31, 2000.

As you progress through the case market rates and yields will change based on how the Fed Funds rate changes.

In the first quarter of the simulation Fed Funds will remain level, however the yield curve will adjust slightly: long rates will rise a little; and short rates will drop some. In the second quarter of the simulation rates will move in one of four different ways: up 25bp, up 50bp, down 25bp, or down 50bp.

For each quarter after the second quarter rates will tend to move in the same direction they had in the previous quarter. There is roughly a 50% chance that if rate were falling in the prior quarter, they will continue to fall (the same is true for rising rates).

Regardless if rates went up or down in the prior quarter, there is roughly a 16% chance that rates will level. Rates will almost never stay level for more than one quarter.

Comments: Interest rates can be forecast after June 30, 2021. Changing Fed Funds will affect all other market rates (including Prime, etc.) The graphic representation can be altered by using the drop down boxes.

Historical ViewYou can review the bank's initial financial reports here. This is where you will also find the results of the latest competitive run.

Competitive ViewBefore the first decision you will see an analysis of a variety of real banks. These banks represent a variety of economic communities, business strategies and appetite for risks.

After the first competitive run you have a unique view of the position of all the other competing banks in your virtual community. You will find a comparative set of reports with information on each bank in your community. Using the drop down box you can review your competitive position for all previous quarters. This is, in effect, your Peer data.

BANKdynamics will notify you when a competitive decision is due. All participants are encouraged to mark the box next to the What-if they want to enter as a final decision for the quarter. However, only the Leader's selection is accepted. (See Team Administration)

Remember these projections do not take into account the affects of competition. The analysis is a view of the results of your assumptions without any outside market factors. Your competitors may make decisions that add or detract from any market share or other factors that you are striving to gain. Also, rates changes can be hypothesized, but the Fed makes the final decision on rates.

Projected Goal Performance shows you the projected ratios (related to your management goals) that result from your current What-if.

Projected Market Performance shows you the projected market measurements that will result from your current What-If.

Projected Overall Performance is hyper linked to full reports. Click on either the bar or the narrative description and see detailed analysis.